Indonesia's central bank gave Singapore's DBS Group Holdings Ltd its long-awaited approval on Tuesday to buy a 40 percent, or $2.7 billion, stake in PT Bank Danamon Indonesia Tbk , a year after DBS proposed a majority takeover.

Bank Indonesia, as part of its approval, said for DBS to purchase more of Danamon, Singapore would have to allow Indonesia's banks greater access to its $33 billion financial services industry.

Singapore replied that it was looking into ways to provide such access.

Whether that statement was a sign of genuine progress is not certain, analysts say. In the meantime, DBS's attempt at a full, $7.2 billion takeover of Danamon remains in limbo.

"The key issue will be whether MAS follows up on it quickly with action," said Jake Robson, a partner at Norton Rose, referring to Singapore's central bank. "And, if so, whether Bank Indonesia then shows some form of leniency to DBS in allowing it to go beyond 40 percent."

The suggested reciprocity is seen by analysts and bankers as implying full banking licenses in Singapore, or Qualifying Bank Licenses (QFBs) which allow foreign banks to open several branches in the city-state and accept retail deposits.

Singapore has promised to open up its financial services sector to Indonesian banks, in the areas of wholesale banking and limited retail banking for Indonesian students and workers.

Analysts said Indonesia will press Singapore to allow its banks to operate in the city-state with QFB licenses, but will likely seek a waiver of tough capital requirements under the licensing regime.

"It is not clear to us that MAS would be willing to waive the significant capital usually required to support these full banking licenses for the three Indonesian banks," said UBS analyst Stephen Andrews in a note.

Under the QFB regime, foreign banks are allowed to have a branch or ATM machine in up to 25 different locations within Singapore.

Danamon shares fell 2.5 percent on Wednesday, while DBS shares hardly moved. The relatively small movement in both stocks, given the flurry of news overnight, showed that investors are still unclear as to whether a full takeover will succeed or not.

POLITICAL OBSTACLES

Last year MAS said that in future, any new banks that get QFB licenses as part of Singapore's Free Trade Agreements (FTA) with other countries would have to incorporate locally in the city-state first. That would mean they would need to meet the local capital requirements, which are higher than the globally agreed Basel III regime.

Singapore currently has no FTA with Indonesia but both countries are signatories to the ASEAN Framework Agreement which aims to create a single market for trade and services by 2015. Financial services and transport will also open up progressively.

Analysts said even without the reciprocity element, DBS' proposed purchase of a majority stake in Danamon could take 18 months as the target would have to pass three financial-soundness tests.

It could also face political obstacles.

Indonesian MPs said on Wednesday they want a new banking law, under discussion since late last year, to limit foreign ownership to a maximum of 50 to 51 percent and suggested it could make it to the statute books by next year.

Ratings agency Fitch said in a note that a minority stake would not sit well with DBS, given new global regulations. Fitch said a stake of anywhere between 10 to 50 percent may be capital-inefficient under Basel III regulations, as it needs to be deducted from regulatory core capital if the investment amount exceeds certain thresholds.

Fitch, however, said in the note that DBS could decide to stay put, even if it owned a minority stake.

"Expanding its pan-Asian franchise is a long term strategy, so the growth potential in Indonesia may still offset these limitations," the ratings agency said.

Under its original proposal, DBS wanted to buy 67.4 percent of Danamon from its majority owner, Singaporean state investor Temasek Holdings (Private) Ltd , then buy the rest from minority shareholders. Temasek also owns 29 percent of DBS.

"Without a clear, undisputable path to control within a sensible timeframe, we think DBS may need to reconsider its options," said Andrews, of UBS.

Danamon shares closed slightly down on Wednesday, dipping 1.7 percent in a flat market, while DBS shares were barely changed. The relatively small movement in both stocks indicated that investors are still unclear as to whether a full takeover will succeed or not.

($1 = 1.2617 Singapore dollars)

(Reporting by Andjarsari Paramaditha and Randy Fabi in Jakarta, Rachel Armstrong and Anshuman Daga in Singapore, and Umesh Desai in Hong Kong; Editing by Daniel Magnowski and Michael Flaherty)